Enrique Arzac

The Leverage Structure of Interest Rates

Download:

Adobe Acrobat PDF

Abstract:
The article presents several lender supply and borrower demand conditions for a leverage structure of interest rates. The paper presents a model of the credit transaction between individuals embedded in a competitive credit market. In this model, the individual has to decide on the optimal allocation of his initial investible capital K, among a risk asset with random rate of return R-1 available to all investors, a riskless asset with return s-1 and lending to or borrowing from another individual. Short sales of the risk asset are not permitted. On the supply side, positive marginal utility of wealth is the only restriction required to make an increasing leverage structure necessary for an interior maximum of the lender's utility function. On the demand side, risk averse borrowers will support an increasing leverage structure by demanding loans at more than one point on the structure if, besides some other mild assumptions, there are differences in wealth among borrowers or differences in the degree of absolute or relative risk aversion.

Close Window